Interest rates look to remain higher for longer against a backdrop of strong oil prices and a rising US dollar – overshadowing modest UK gains and US losses over the month.
Wesleyan’s Director of Investments, Martin Lawrence, explores the key themes driving the global economy and financial markets, and sets out our views about the investment environment and outlook for returns.
Market moves that matter
Long-term interest rates move higher
Rising oil prices and a robust US dollar grabbed the headlines in September, but these factors were overshadowed by the outlook for interest rates in bond markets moving higher. The UK stock market recorded a modest gain, while many European and Asian markets fell. US stocks dipped by around 5% in September, though losses were softened by a strong dollar. Overall, some US stocks have performed exceptionally well in the first nine months of the year.
Long-dated government bonds tumbled, after buckling under the weight of higher longer-term interest rates. Nevertheless, US Treasury Secretary Janet Yellen remains confident the US economy can avoid the severe recession some were fearing earlier in the year. The most recent US wage data showed signs of moderating, while unemployment remained low and stable.
Headline US inflation rose, but core inflation – which strips out volatile energy and food prices – retreated, with key measures converging around 4% in August.
Economic growth remains muted
The latest economic data suggest the US economy slowed in each of the past four quarters. Recent concerns about the health of China’s property sector gave way to hopes for more government stimulus in September. Cuts to reserve requirements for Chinese banks alongside better-than-expected mid-month economic data revived global equities – including mining shares, which helped the performance of the UK’s stock market.
US Fed pauses rate hikes
Both the US Federal Reserve (Fed) and Bank of England left interest rates unchanged in September, while the European Central Bank (ECB) hiked by 0.25 percentage points, prompting speculation they may now remain on hold. In contrast, rates may rise further in the US and UK. This is perhaps not the key focus though, with more importance being placed on how long rates stay high.
The Bank of England’s Chief Economist likened the UK’s rate peak to a ‘Table Mountain’ rather than ‘Matterhorn’ profile, implying rates could plateau at high levels for some time, as opposed to spiking then rapidly falling. Adjusting to higher-for-longer interest rates can be a painful process, as evidenced by the yield on 10-year US Treasuries rising to over 4.5%, which is the highest in over 15 years and now above equivalent UK gilts.
Investment views
UK house prices drop further
Higher interest rates make it expensive to service outstanding debts, which is as true for household mortgages as it is for the highly indebted US government, where a shutdown was narrowly avoided at the end of September. Yet the precarious fiscal position remains.
In the UK, the housing market fell harder in August than September, but it takes time for the full impact of higher mortgage rates to be felt. Further falls can be expected judging
by the softness we are seeing in mortgage approval numbers from the Bank of England.
Inflationary pressures ease slightly
Inflation numbers in the UK were a pleasant surprise in September, with CPI inflation for the month of August much lower than had been expected. But wage growth is arguably the greater concern at the moment – evidenced by the 8.5% headline for the annualised three-month period to July. But that data is somewhat out of date and there are reasons to believe that wage pressures could ease in the months ahead.
Cautious optimism
UK economic growth remains positive but has ground to an effective halt and the Bank of England could soon become more concerned about economic growth than they are worried about inflation if current trends continue. For the time being, as interest rates remain elevated, we continue to view the returns available on fixed income investments, such as government bonds and corporate bonds, as attractive and appropriate for many of our funds where we can lock into these higher rates for longer periods of time.
The period of adjusting to higher rates has been a painful one over the past few years but we believe the foundations for future long-term returns are now being laid.
Please remember the value of investments and any income can go down as well as up and you may get back less than you invest.